Cliff Notes: the consumer is critical to the outlook
Key insights from the week that was.
This week, Australia’s Q4 GDP report and monthly consumer/housing releases provided a broad update on the health of Australia’s economy and its outlook. Offshore, the diverging prospects of the US and China were on display.
Q4 GDP for Australia came in well below the market’s expectation at 0.5%, 2.7%yr. In the event, the main surprise was an abrupt slowdown in household spending growth, which fell from 1.0% in Q3 to just 0.3% in Q4. Despite support for consumption from a 2.1% lift in nominal wages and a decline in the savings rate from 7.1% to 4.5% – freeing up roughly $9bn in spending capacity – intense cost of living pressures and rapidly rising interest rates saw a 2.2% decline in real disposable incomes, leading households to restrict their spending particularly on services.
With the tailwinds from earlier policy stimulus and reopening dynamics having now faded, the report suggests consumption growth will remain under pressure this year as the full effect of higher interest costs and inflation’s hit to real incomes continues to materialise (see below). Conditions for investment were lacklustre, the fall in construction work and decline in equipment spending leading a -0.8% decline in new business investment. Though, with capacity tight and tax incentives supportive, businesses remain constructive on the outlook for investment over the coming year.
More positively, Australia’s current account surplus widened from $0.8bn in Q3 (revised up from a deficit of $2.3bn) to $14.1bn in Q4, thereby marking 15 consecutive quarters of surplus, the longest run in the history of the series which dates back to 1959. As evinced by the 1.1ppt contribution from net exports to GDP growth, Australia’s trade position proved to be a key support for the economy into year-end. Indeed, the trade surplus widened to $41bn in the quarter as services exports bounced 9.8% thanks to the recovery in tourism and foreign student arrivals, while total import volumes posted a broad-based decline of 4.3%.
Another batch of volatile housing data meanwhile broadly reaffirmed our view on the outlook. Of note, dwelling approvals posted a much larger-than-expected decline of -27.6% in January, partly representing an unwinding of the high-rise unit spike of December, though the sharp 13.8% decline in private sector house approvals suggests the broader weakening remains well entrenched. However, the CoreLogic home value index fell by only 0.1% in February – a seemingly stable result corroborated by a slowing in price declines across all major capital cities. It should be noted that early-year housing data is prone to low-season measurement issues, distorting the finer interpretation of these results and warranting confirmation over the next few months of data.
As noted above, the Australian consumer will be at the epicentre of the slowdown in growth over 2023. This is supported not only by the clear softening in consumer spending in the national accounts, but also the accumulating evidence of underlying weakness within the retail sector, growth in sales having effectively stalled on a three month basis. Although the retail sector only accounts for around a third of total consumer spending, it is clear that broader inflation pressures remain at an uncomfortable level (despite month-to-month volatility) and are eroding household’s real spending capacity, the full effect of which will likely be a stalling in household consumption during second half of this year.
Moving offshore, the most significant US release this week was the ISM manufacturing survey for February. Overall, it pointed to continued contraction in the manufacturing sector and a belief that this trend will persist – the new orders series printing at 47.0 versus production’s 47.3. Relative to the headline and activity outcomes, employment remains resilient, the index indicating only a marginal reduction in labour use. The prices paid (for inputs) series received the most attention from the market, as it rebounded from 44.5 to 51.3 in the month. Some context is needed here, however. In the two years to June 2022, the height of the pandemic inflationary wave, this index averaged 78. Indeed, in the five years before the pandemic (to end-2019), the average was still 56. While inflation risks have to be monitored wherever they appear, we also have to be realistic on the significance of the signal. With respect to businesses, it is also worth mentioning that, taken together, the durable goods data and regional business surveys point to continued weakness in business investment.
This week’s housing data was also consistent with a sector that is stagnant to down. Residential construction fell a further 0.6% in January after a run of large negatives through late-2022. While the S&P CoreLogic CS 20-city house price measure fell another 0.5% in December. That said, when interest rates and supply allow, there is still demand for housing, pending home sales snapping 8.1% higher in January while mortgage rates were at their recent lows. Note though that pending homes sales are still 22% lower than a year ago and also that the 30-year mortgage rate is back near its cycle highs.
Turning to China, the official PMIs from the NBS confirmed this week that the economy has responded well to the end of COVID-zero, the manufacturing PMI rising to 52.6 and the services index to 56.3. For both sectors, output, new orders and employment all rose strongly. Service producers also reported an expansion of their profitability, with input costs inflation slowing as selling prices rose. Notable too was that the Caixin manufacturing PMI gained a similar amount as the NBS PMI. This points to smaller manufacturers also experiencing the benefit of the rebound.
Taking a longer-term perspective, this week we also investigated the outlook for Chinese industry associated with the global green transition. While the US has sought to curb China’s capacity and influence through the Inflation Reduction Act and their semiconductor regulation, the evidence suggests China’s dominance in many green industries is unlikely to be challenged. Simply, the Chinese product that the US decides to forgo can instead be marketed to Asia and other developed/developing nations across the world. The sale price may be lower in such a situation, but China’s efficiency and scale of production will make up for it. China’s own demand for green energy and transport will also remain strong for decades to come.
The negative consequences of the US’ actions are therefore likely to fall on their own economy, with limited supply and higher prices for related goods likely, particularly in the continued absence of rapid, large-scale investment in new capacity. The fringe risk for the global economy and environment is if the US encourages other developed markets to take a similar position against China. But, as for the US, the outcome of such a decision would likely be a slower path of emissions reduction at a higher cost; meanwhile China will continue to lead and profit from developing markets’ long path towards net zero. Ironically, China may even find its political and economic position strengthens as a result of the US’ hard line.
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